At first glance, Nvidia (NASDAQ: NVDA) may not look cheap. Nvidia stock sells for 40 times earnings. The share price has soared 1,241% in five years largely on the back of surging demand for AI chips. But, for now, the jury is out on just how sustained the AI demand might turn out to be.
Still, with the sort of phenomenal value creation we have seen from Nvidia stock, the world’s largest company by market capitalisation certainly grabs my attention.
Even now, could there possibly be scope for future gains in the share price?
Lots to play for
I think there could be.
In fact, I think there could possibly still be scope for substantial further gains in the price of Nvidia stock.
Sometimes it can feel as if Nvidia is the new kid in class, riding on the coat tails of an explosion of investor interest in AI over recent years.
The reality is that the company’s recent success has been decades in the making.
Nvidia has long been an innovator. Its revenues and profits have surged over the past few years but that has built on a proven business model Nvidia has nurtured over decades.
It has deep client relationships, a large installed user base, and reams of proprietary technology.
If AI demand keeps growing, I think Nvidia’s sales, and earnings could keep growing at a fast clip. The most recent quarter saw sales revenues rise by a fifth year on year: clearly even at its huge scale, Nvidia has lots of momentum.
Should business results keep going in a positive direction at speed, I think that could well mean we see the Nvidia stock price move higher from here.
Why I’m interested, but not buying for now
So, given my bullishness about the prospects for the business, why am I not yet ready to put any money into buying the share?
In a word: valuation.
I said above that Nvidia stock trades on a price-to-earnings (P/E) ratio of 40. But bear in mind that that number is based on current earnings.
Nvidia’s earnings growth has been dynamic in recent years. Last year’s basic earnings per share, for example, were around 27 times higher than they had been just three years beforehand.
If Nvidia can keep growing earnings – even at a much more modest pace — the prospective P/E ratio could be far below 40. In that case, Nvidia stock may turn out to be much cheaper today from a long-term perspective than it currently seems.
A complex range of risks
But for that to happen, a lot of things need to go right.
Demand for chips needs either to grow or at least stay at current levels. Nvidia needs to maintain technical advantages that can help it sustain its substantial pricing power. That may become harder as many rivals, eyeing its recent success, are themselves innovating their offering to try and grow their market share.
On top of that, Nvidia needs to navigate an already complex geopolitical environment that threatens to become even more so.
Those things could happen – and we may see Nvidia stock move higher. But the current price does not offer me the margin of safety I would like given such risks.
